BoJ rates strategy blambed for global currency ‘bar brawl’

Share via

The Governor of the Reserve Bank of Australia appeared to attack his counterparts at the Bank of Japan (BoJ) yesterday for unwittingly encouraging massive speculative positions through the global yen carry trade.

Glenn Stevens’s comments came at the end of a week of unprecedented currency volatility that saw every major exchange rate wrenched around in what one senior Deutsche Bank broker called an “international bar brawl with no cops in sight”.

At the centre of the mel?e has been the yen - the currency believed by some to be at the core of a massive, long-term mispricing of risk by hedge funds. The investment strategy known as the yen carry trade may have been the basis of nearly a decade of cheap financing for speculative investments.

As that trade was unwound, the yen surged to its biggest weekly gain against the US dollar in almost nine years. It has also made large gains against the Australian and New Zealand dollars this week. The Reserve Bank of Australia intervened to prop up its dollar for the first time in six years yesterday, reducing losses versus the yen over the past two weeks to about 20 per cent.

Behind the unquantifiable yen carry borrowing frenzy has been the controversial decision by the Bank of Japan nearly a decade ago to cut its interest rates to nearly zero and keep them there as the Japanese economy clawed its way out of slump.

In his half-yearly testimony to the Australian Parliament, Mr Stevens described Japan’s interest rates, which are still only at 0.5 per cent, as “fundamentally a distortion”. To restore some stability to global financial markets, he said, Japan’s interest rates must be returned to “normal”.

But he added that it was clear why the Japanese central bank acted as it did during credit and banking crises: “I would have cut them to the same point if I had been in charge there, so it’s not a criticism.”

The Australian dollar and currencies of other commodity-rich economies such as Canada and New Zea-land have been favourite “destination currencies” for investors exploiting the carry trade.

Economists said there was little likelihood of Japan’s sluggish normalisa-tion being accelerated at the BoJ’s monetary policy meeting next week, and most analysts have abandoned predictions of a modest rate rise next Thursday.

Mr Stevens’s comments confirm the suspicions of many investors that the yen carry trade, though virtually impossible to quantify or track, has been distorting a wide range of markets. Equities, crude oil, copper, soft commodities, fine art, property and vintage wine are all thought to be priced by miniature bubbles that have been partly inflated by borrowed yen.

Jim Wood Smith, a Williams de Bro? strategist, said: “The easiest way to make money has been to borrow cheaply in Japan”.

As well as yesterday’s extraordinary 5.2 per cent collapse in the Nikkei 225 stock index, the Japanese currency blasted higher against the US dollar, sterling and euro in the morning, Tokyo time, then hurled down in the evening when London and New York trading began.

Much of the yen pandemonium centres on the general flight from equities: hedge funds and other “multi-strategy” investors are liquidating profitable assets to meet margin calls or redemption demands.

Chris Wood, a CLSA strategist, said credit was “now in the process of self-destruction as the whole edifice of structured finance is completely discredited”.